On March 11th, 2021, President Joe Biden signed a $1.9 trillion stimulus package into law called the American Rescue Plan Act of 2021, and with that came some exciting news for student loan borrowers.
Section 9675 of the act effectively makes all student loan debt eligible for tax-free loan forgiveness through the end of 2025.
What does this change mean for borrowers, and how should they plan for their student loans?
Understanding Section 9675
The legislation will treat any student loan forgiveness from 2021 through 2025 as tax-free. The definition includes virtually all types of student loan debt used expressly for post-secondary education purposes.
- All federally backed loans: Direct Loans, FFEL, Consolidation Loans, Federal Perkins Loans, and Parent PLUS Loans
- All state-sponsored education loan programs
- All institutional loans made by colleges and universities
- All private loans made to students and parents
The inclusion of state, institutional, and private student loans in the legislation is a massive expansion for student loan borrowers as all federal stimulus aid before the new legislation was limited to federal loan borrowers only.
Does This Mean That Everyone’s Student Loans Are Being Forgiven?
At this point, no.
Currently, there is no legislation in place to execute sweeping student loan forgiveness. To implement loan forgiveness, Congress will need to introduce and pass new legislation.
So, why is this such a big deal?
It has the potential to be a big deal as it is the first major hurdle to providing student loan forgiveness to borrowers.
As previously stated in Solving the Student Loan Problem: Biden’s Executive Order & the Future Outlook of Student Loan Legislation, “Lawmakers will have to determine if forgiveness should be a taxable event or tax–free, resulting in more cost to taxpayers.”
With the tax hurdle out of the way, the next major hurdle may be debt forgiveness itself. But this means lawmakers must answer the nebulous questions surrounding debt-forgiveness (e.g. who should have their debt forgiven? And how much?). The answers are nowhere near as simple as some seem to think.
Furthermore, while this rescue package has helped set the foundation for student-debt forgiveness, the constitutionality and mechanics of forgiving student debt are still quite hazy.
Executive Order vs. New Legislation
There are two paths to pursue student loan forgiveness: a presidential executive order or congressional introduction of new legislation.
Unfortunately for borrowers, it may be the latter. The challenge with the president issuing an executive order to forgive student loan debt is that it may not be legal and could result in a lengthy and unsuccessful court battle. On January 12th, 2021, the Principal Deputy General Counsel of the U.S. Department of education, Reed Rubinstein, issued a memorandum to the former secretary of education in which he stated,
“We believe the Secretary does not have statutory authority to provide blanket or mass cancellation, compromise, discharge, or forgiveness of student loan principal balances, and/or to materially modify the repayment amounts or terms thereof, whether due to the COVID-19 pandemic or for any other reason.”
As a result, we will most likely see the introduction of new legislation by Congress in an attempt to forgive student loan debt.
Reconciling Loan Forgiveness and Budgeting Issues
The main challenge that Congress will face is the significant budgeting challenge. There are over 1.7 trillion dollars of outstanding student loan debt today.
Forgiving $10,000 for every student loan borrower would cost the American taxpayers approximately 377 billion dollars. Increasing the amount of forgiveness to $50,000 per borrower would cost over 1 trillion dollars.
In addition, the government has spent vast sums of money providing stimulus aid through the COVID pandemic. The Congressional Budget Office figures show the 2020 U.S. budget deficit was a record 3.1 trillion dollars in 2020 and project a 2.3 trillion dollar deficit in 2021. Budgeting restrictions will inevitably factor into the amount of aid the government can provide for borrowers in the future.
Student loan forgiveness will most likely happen in some way, shape, or form, but it may be limited due to the government’s budgeting abilities.
The government’s primary focus will be to help those most in need. As a result, we will likely see a $10,000 forgiveness at some point, but it may be limited to those under certain income thresholds. Additionally, the government could restrict aid to loans acquired for undergraduate debt, further reducing the American taxpayers’ burden.
There is a possibility that we may see a small forgiveness each year through 2025 and a potential that the tax-free forgiveness could be extended in the future or become a permanent fixture to student loans. However, these ideas are highly speculative.
What Should Borrowers Do?
Borrowers should remain cautiously optimistic. There is no guarantee the government will forgive student debt. Additionally, if and when it happens, we do not know who will qualify, nor do we know what amount will be forgiven.
Strategies to Consider:
- Private student loan borrowers should continue to pay their loans on time and remain in good standing with lenders.
- Federal student loans are currently set at a $0 payment and 0% interest accumulation through September 30th, 2021. Borrowers should consider saving the amount they would have paid in student loan debt in an account that is liquid, safe, and has the potential to earn a rate-of-return. Stay current with new legislation throughout the year, consider making a lump-sum payment by September 30th, and resume payments when they are due.
- Grad PLUS borrowers on an Income-Driven Repayment plan, such as PAYE, REPAYE, or IBR, should continue to save for a potential student loan tax burden.
- The first of these borrowers to become eligible for loan forgiveness will be in 2032, well beyond the 2025 tax-free window.
There are many highly efficient strategies to save for both a student loan tax burden and retirement simultaneously. With the right planning, borrowers may find themselves ahead of the curve if the government extends the tax-free window in the future.
These strategies are varied and can be complex depending on your personal situation. If you need help, please schedule a free consultation with one of our coaches.
Section 9675 of the American Rescue Plan Act of 2021 is a big deal.
For all the challenges that have come with the global pandemic, one of the positive aspects is that it has made the student loan problem a staple topic of conversation with legislators. Hopefully, the discussion will not lose weight or momentum as we approach the end of the pandemic and return to a sense of normalcy.
In the future, we still need legislators to address the cost of college, the inflation rate of tuition, and the student loan problem in a fair, equitable, and unifying way. College is outrageously expensive, and we will never solve the problem if we do not directly address college costs.
Until then, stay informed, remain cautiously optimistic, make smart money decisions and seek professional help when needed.